Most rules come with exceptions. Including federal tax rules.
The Tax Cuts and Jobs Act (TCJA) eliminated the federal deduction for interest on home equity debt, effective beginning in 2018 and extending through 2025.
The exception? Home equity loans or home equity lines of credit used to substantially improve the home.
According to the IRS, home equity debt that is used for substantial home improvements is deductible, subject to limitations and exceptions. As a general rule, if you use the debt for anything other than home improvements, perhaps to pay off a credit card or to purchase a new car, the interest is not deductible. Not surprisingly, there are exceptions here as well. If you use the debt for investment or business purposes, it may be deductible.
Importantly, the Act also changed the rules limiting the mortgage interest deduction. Beginning in 2018, this deduction is limited to the first $750,000 of mortgage debt ($375,000 for married filing separate). This limit applies to the combined amount of loans used to buy, build or improve the main home and second home — including the otherwise qualifying home equity debt.
Mortgage debt that existed prior to the 2018 rule change is grandfathered in at the previous limit of $1 million in mortgage debt ($500,000 for married filing separate). Any pre-2018 qualifying home equity debt is subject to the same (combined) $1 million limit.